Tag Archives: management

3 Mid Cap Growth ETFs To Buy For Q4

Increasing uncertainty pertaining to the China turmoil, global growth worries, slumping commodities and timing of the interest rates hike in the U.S. are general concerns. In this backdrop that has lasted for quite some weeks now, the broader U.S. market has trapped itself in a nasty web of trading. While the U.S. economy is on a firmer footing, calling for a rates hike sometime later in the year, the fundamentals in other developed and developing markets are deteriorating. This is especially true given the slowdown in Japan, sluggishness in Europe, technical recession in Canada and weak growth in emerging markets. Additionally, investors are wary of third-quarter earnings, which are expected to drop 5.8% on 3.9% lower revenues for the S&P 500 index, as per the Zacks Earnings Trends . Moreover, the ongoing battle over the funding for Planned Parenthood between Republicans and Congress could lead to the possible shutdown of the federal government at the end of the month. All these conditions are increasing the volatility in the market, putting the stocks’ returns at risk. However, the bullish sentiment for U.S. stocks remains intact given the substantial improvement in the economy and a healing job market. In such a scenario, investors seeking to participate in the growing economy, but are worried about uncertainty, should consider mid-cap stocks in the basket form. Why Mid Caps? While large companies are normally known for stability and smaller ones for growth, mid caps offer the best of both the worlds, allowing growth and stability in portfolios simultaneously. These middle-of-road securities are arguably safer options and have the potential to move higher in turbulent times, especially if political issues or financial instability creeps into the picture. Further, honing in on growth securities in this capitalization level allows investors to earn more returns. This is because growth stocks refer to those high quality stocks that are likely to witness revenues and earnings increase at a faster rate than the industry average. These stocks harness their momentum in earnings to create a positive bias in the market, resulting in rocketing share prices. There are currently a number of ways to tackle this overlooked part of the market segment through ETFs, giving exposure to various styles including broad, value and growth. With such a large number of choices, it may be difficult to choose the right funds. After all, many of these products target the same securities though they have different tilts, weighting schemes or focus for their portfolios. How to Pick Right ETFs? One way to narrow down the list is to utilize the Zacks ETF Rank. This system looks to find the best ETFs in a given market segment based on a number of factors such as industry outlook and expert surveys; and then apply ETF-specific factors (like expense ratios and bid/ask spreads). And given the rise of the outlook for mid caps of late, it shouldn’t be too surprising that a few have moved to the top Zacks ETF Rank of 1 (Strong Buy) from Zacks ETF Rank 2 (Buy) or 3 (Hold) in the latest ratings’ update. Below, we have highlighted these three surging funds in brief detail for investors seeking a way to make a great play on the overlooked mid cap growth space in basket form: Vanguard Mid-Cap Growth ETF (NYSEARCA: VOT ) This fund follows the CRSP US Mid Cap Growth Index. Holding 177 securities in its basket, it is highly diversified across each component with none holding more than 1.5% share. In terms of sector exposure, industrials occupies the top position at 19.3%, followed by consumer services (19.2%), technology (14.7%), and consumer goods (14.2%). The product has managed nearly $3.4 billion in its asset base and trades in moderate volume of around 177,000 shares. Expense ratio came in at 0.09%. VOT has lost 1.6% in the year-to-date timeframe. iShares Morningstar Mid-Cap Growth ETF (NYSEARCA: JKH ) With AUM of $217.4 million, this product tracks the Morningstar Mid Growth Index. In total, it holds 204 mid cap securities with none accounting for more than 1.53% of assets. Information technology, industrials, consumer discretionary, health care and financials are the top five sectors with double-digit exposure each. The ETF charges 30 bps in annual fees and trades in a light volume of less than 5,000 shares a day. It has shed 2.2% so far this year. Vanguard S&P Mid-Cap 400 Growth ETF (NYSEARCA: IVOG ) This ETF tracks the S&P MidCap 400 Pure Growth Index, charging investors 20 bps in fees per year. It has amassed $379.3 million in its asset base while sees a light volume of less than 13,000 shares. The fund holds 229 stocks with a well-diversified portfolio as each firm holds no more than 1.4% of total assets. However, it is skewed toward financials with one-fourth share while information technology, consumer discretionary, industrials and health care round of the top five. The ETF has gained 1.6% in the year-to-date timeframe. Link to the original article on Zacks.com

NRG Energy – Adding Value With A Business Restructuring

Summary NRG Energy’s dream of building one of the first integrated fossil fuel and clean energy businesses will go unfulfilled. NRG Energy plans to spit off its clean energy business in a few months time, forming what will be known as “GreenCo.”. While the fossil fuel and clean energy business have many synergies, a separation of these two businesses is likely more viable in the current investment atmosphere. NRG Energy’s clean energy business will have to compete with ultra-competitive solar companies as a standalone company, which could prove to be a large obstacle. Over the past few years, NRG Energy (NYSE: NRG ) has stood out in its attempt to become the first major integrated fossil fuel and renewable energy company. While the company has successfully integrated these two businesses to some extent, there have been many obstacles that have limited NRG Energy’s overall success in this endeavor. There are many aspects of the distributed solar business, in particular, that do not mix well with the traditional fossil fuel power business. While these two businesses are not at odds in theory, the relatively unproven distributed solar business has made investors wary. As such, the company decided to split off its clean energy business into what will be known as “GreenCo.” Here is a chart explaining why NRG Energy is planning to split off its clean energy business. (click to enlarge) Source: NRG Energy Integration Problems NRG Energy’s plan to integrate a large clean energy business was not flawed in theory. NRG Energy could use the comparatively vast resources from its fossil fuel business to help catalyze its burgeoning clean energy business. This would put the company at a financial advantage against pure play clean energy companies like Vivint Solar (NYSE: VSLR ). However, the downsides associated with such integration seem to be outweighing the benefits. One of the main problems with this strategy is that fossil fuel and clean energy investors are generally of different mindsets. Fossil fuel investors are usually more interested in more stable businesses, whereas clean energy investors are more interested in growth. While NRG Energy’s clean energy business has enormous growth potential, many fossil fuel investors are likely off-put by the segment’s more risky nature. On the flip side, many clean energy investors are likely put-off by NRG Energy’s relatively low growth fossil fuel business. While there are indeed many investors that find the combination of businesses attractive, it seems as if separating these two businesses would attract more investors on balance. In addition, both the fossil fuel and clean energy businesses require a huge amount of attention. Pure-play distributed solar companies like SolarCity (NASDAQ: SCTY ) already have their hands full just managing their specific businesses. In NRG Energy’s case, distributed solar is just one segment in a larger business portfolio. It is unlikely that the company would be able to invest the optimal amount of time and energy into all of its businesses. While many synergies certainly do exist in NRG Energy’s fossil fuel and clean energy businesses, it seems as though separating the businesses would unlock more value due to the combination of current investor sentiment and limited attention/resources. Pure-Play Approach NRG Energy’s pure-play approach will likely attract more investors over the long-run. However, this also means that its renewable spin-off will be competing against the likes of SolarCity, Vivint Solar, etc, with much less assistance. The big financial advantage of NRG Energy’s clean energy businesses will mostly disappear once the company is spun-off from its fossil fuels business(NRG Energy is planning to give the GreenCo a financial limit of $125M in 2016). With that being said, NRG Energy’s clean energy business is still doing relatively well, and will likely succeed even without the help of the company’s main business. NRG Energy believes that there is ~$1B that can be unlocked by spinning off its clean energy business, which could very well be true given the benefits of separation. As investors will likely favor this strategy, as was mentioned before, NRG Energy is likely going down the correct path. Shareholders should benefit from the company’s planned pure-play approach, especially given the increasing complexities of the clean energy business. While CEO David Crane’s integrated energy plan was sound in principle, it may have been too early to implement this as investors have not fully committed to the idea. Obstacles While there are definitely many positives associated with a clean energy spin-off, the company could find it difficult to adjust as a pure play. Also, the company may have more trouble financing its operations as was mentioned before. Whereas the NRG Energy’s clean energy business currently has an advantage in financing due to its relationship with NRG Energy’s fossil fuel business, this will no longer be the case after the spin-off occurs. Competing against well-established companies like SolarCity and Vivint Solar could prove to be more difficult than expected. Regardless, the distributed solar market in particular is still incredibly underpenetrated, which means that NRG Energy’s GreenCo has great growth opportunities. Conclusion While NRG Energy’s grand plan to integrate massive fossil fuel and clean energy businesses has been derailed, the company is still undervalued at a market capitalization of $5.1B . Given that most of the company’s growth potential lies in its clean energy segment, NRG Energy may no longer be undervalued after it splits off its clean energy business. In theory, the synergies of NRG Energy’s fossil fuel and clean energy business should have outweighed the negatives of such integration. With that being said, investors are still largely uncomfortable with this idea, thus making the planned spin-off a smart decision for shareholders.

Atmos Energy – Great Company, But Overvalued

Summary Atmos Energy operates in highly favorable operating and regulatory environment. The company is a Dividend Aristocrat, having raised its dividend for over 31 years now. However, the company is overvalued. The yield is too low compared to historical averages and the company’s overspending of its cash is worrisome. Atmos Energy Corporation (NYSE: ATO ) operates primarily as a regulated natural gas distributor, in fact it is one of the largest pure play natural gas operations in the United States. Based out of Texas, he company has operations stretching across eight states serving over three million customers. Given its location, Atmos Energy has access to cheap natural gas sourced from the Val Verde and Barnett shale plays. Further bolstering the company is a favorable regulatory environment. Both Texas and neighboring Louisiana have company-friendly utility policies in the form of annual rate filing mechanisms. These allow Atmos Energy to put in requests to modify its rates on an annual basis without filing a formal rate request. What this means is that the company can recover a majority of capital expenditures and commodity prices from customers quickly. These two factors have created a prime situation for Atmos Energy’s utility operations. Overall, Atmos has been a consistently profitable business that has rewarded shareholders greatly over the years. The company is a member of the oft-observed Dividend Aristocrats index (companies with 25 or more years of consecutive dividend increases), which has led to Atmos Energy finding itself in many retail investor portfolios due to its strong yield and proven track record. But is the future for Atmos Energy as bright as the past? Company Track Record (click to enlarge) Total revenue has grown at a 3.74% pace since 2011. In reality, this understates growth as the company sold some of its natural gas distribution operations in four states as part of a streamlining initiative (Missouri, Illinois, Iowa, Georgia). Investors can see that this divestiture was wise as it likely contributed to improved operating margins from fiscal 2013 forward. Like I do with most utilities, I like to see how cash flow is used by the company. Dividend-paying companies have two main uses of cash outside of operational activities; capital expenditures and dividend payments. At worst, I like to see cash flow from operations = capital expenditures + dividend payments. As you can see, Atmos Energy has traditionally run a deficit on this metric. What this means is that the company has to raise cash to meet all of its obligations, either through debt or a dilutive stock offering. As should have been expected, Atmos Energy raised $386M net cash in 2014 from a stock issuance (9.2 million shares), the announcement of which sent shares plunging (shares have since recovered). Atlas has no plans to slow down capital expenditures, which the company has said is needed primarily to maintain pipeline integrity and general system improvements. In fact, capital expenditures may reach $1.1B annually by 2018 according to company estimates. I would expect Atmos to raise some funds in the debt markets in 2016 or 2017, possibly in the range of $500M, given its solid credit ratings. Application of the Dividend Discount Model As I highlighted in a prior article , the dividend discount model is a great way for conservatively valuing dividend companies, especially those with stable and proven track records. We can generate a valuation of Atmos Energy with the following assumptions: $1.65 expected dividend next year, an 8% discount rate, and 2.5% average annual dividend increases going forward (below the current three year average of 2.9% but below the ten year average of 2.0% increases). P = 1.65 / (.08 – .025) P = 1.65 / 0.055 P = $30/share This gives us a fair value of $30.00/share, indicating that shares might be overvalued based on the expected future cash flows to be generated from our investment. Further support of this relative overvaluation can be found in the five year dividend yield average for Atmos, which has historically averaged 3.80%, which would put fair value of shares at the $44-45/share range. Given the yield currently stands at 2.81%, I believe that shares may have appreciated in value too much compared to recent company earnings. Conclusion Atmos has a strong set of operations in a highly desirable area. Management history of rewarding shareholders is healthy. However, this status has made the company’s stock a bit crowded, especially given the risks related to the expected continued leveraging given the operational cash flow deficit. In my opinion, for investors that want safety, there are better picks in the utility or dividend aristocrat space that would present less material downside risk. At current prices, I simply could not become a shareholder.